How to Make Budgets and Politics a Less Toxic Mix: Clive Crook

Feb. 8 (Bloomberg) -- It has come to something when the International Monetary Fund, that stone-faced inspector of fiscal rectitude, advises governments to go easy on austerity.

The IMF’s budgetary advice usually selects from three options: raise taxes, cut public spending, or raise taxes and cut public spending. Here’s what it said in its Jan. 24 Fiscal Monitor. (Don’t let the sparkling prose sway you unduly.) “Continued adjustment...should ideally occur at a pace that supports adequate growth in output and employment. Given the large adjustment already in train this year, governments should avoid responding to any unexpected downturn in growth by further tightening long as financing is available and sustainability concerns permit. Countries with enough fiscal space, including some in the euro area, should reconsider the pace of near-term adjustment.”

To followers of IMF pronouncements, that’s pretty startling. It makes you wonder just how bad things are. Quite bad, actually. Last week’s new-jobs figures showed the U.S. economy gathering a little momentum, but the recovery is still pitifully slow and the circumstances holding it back -- a flattened housing market, over-indebted households and anxious consumers -- haven’t gone away. And there’s no good news from Europe. Most forecasters expect it to slip back into a recession this year.

The Credibility Gap

Here’s the point: Fiscal policy could be helping, but mostly isn’t. In the U.S., the stimulus is gone and Congress is reluctant to extend it. There’s room for stimulus in Germany and other countries, but they have decided not to use it. The U.K. chose too much austerity too soon; it has clobbered growth and has put fiscal stability further out of reach.

The IMF’s prescription is right: short-term fiscal accommodation where possible, and long-term restraint where necessary (which is almost everywhere). The question is, why is such advice even necessary? Why is getting fiscal policy right so hard?

The underlying problem is always the same: credibility. A severe recession pushes public debt higher. Governments need to allow this, but within limits. Some of the increase in public borrowing is self-correcting. Recessions automatically suppress tax revenue and increase spending on unemployment benefits as well as other safety-net programs. This unwinds when the recovery comes. Governments then add discretionary stimulus, which may or may not be temporary. They have to convince lenders that they will deal with this increase in borrowing later.

Today’s discretionary stimulus, however, means higher taxes or lower public spending someday. Governments can leave their successors to pick up the pieces. Lenders know the same thing might happen again -- the next government leaves tax increases and spending cuts to its own successors. And so on. This expectation shrinks the fiscal space, as the IMF calls it, and the crunch comes sooner than anybody thought.

That’s the bind. Governments have to convince lenders this isn’t going to happen.

Say “credibility” to an economist and he thinks “rules.” Governments should force themselves (or their successors) to do the right thing. Lately, fiscal rules have been catching on. According to the IMF, 80 countries have some kind of budget rule -- up from seven in 1990.

Their record is mixed. In the U.S., the 1985 Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act rule was soon subverted; a later version worked better, then fell into abeyance. The European Union’s Stability and Growth Pact was a failure. With great fanfare, Europe has just agreed to a new rule, much like the old one. Whether this works any better, we will find out. All these instances show the trouble with rules: If you don’t like them, you can ignore them.

Austerity’s Ugly Politics

Some countries are trying another approach, instead of --or in addition to -- a rule. Edge fiscal policy out of the political arena by telling an independent council or commission to come up with answers, or at least referee the discussion. In some places, this has worked fairly well: in Sweden, for instance.

But you need consensus for this to succeed. Where politics is so polarized that consensus looks impossible, as in the U.S., it’s hard to make an independent commission work. The Bowles-Simpson commission did a fine job, then failed for lack of political support. The biggest mistake of Barack Obama’s presidency, in my view, has been to let that failure happen.

In the end, though, the details of fiscal policy cannot, and should not, be taken out of politics. If democracy means anything, the nuts and bolts of taxes and spending -- choices about who gets what, who pays for what and how big the government should be -- are the proper realm of politics. Those questions, as I say, are irreducibly ideological. But the macroeconomic aspects of budget policy -- debts and deficits -- are in a different category. Perhaps, with a little ingenuity, they could be distanced somewhat from politics, and to good effect.

Imagine an independent agency whose mandate is fiscal stability. It would be the fiscal equivalent of the central bank. Suppose that agency had one, and only one, sufficiently powerful and flexible instrument: a national sales tax, say. It could cut this tax in recessions to provide short-term stimulus, and at other times would set it at whatever rate it judged necessary to stabilize long-term debt. That would be its dual mandate: short-term stability and long-term fiscal solvency.

This Fiscal Stability Board would not be deciding which districts get bridges or defense installations, when people should retire, what medical treatments should attract public subsidy, or how mildly to tax manufacturers and private-equity partners. Above all, it would not be deciding what share of national income the government should spend. All that would fall to elected politicians.

In the U.S., Congress could carry on doing what it loves best: showering favors on its preferred constituencies. But once the legislature had made its choices, the Fiscal Stability Board would decide whether the fiscal balance looked right, short-term and long-term. Much as a central bank sets an interest rate and gives an expected path of future rates, the FSB would then set the sales tax.

I’d swap one Fiscal Stability Board, thus constituted, for any number of rules, pacts, triggers, councils and constitutional amendments. (Speaking of which, in the U.S. its establishment might require one.) An outlandish idea? Not long ago, the notion of central-bank independence seemed bold, as well. If it can be done for monetary policy, I don’t see why it shouldn’t be done for the relevant aspects of fiscal policy, too.

(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)

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